Virginia has posted draft guidelines of its new Pass-Through Entity Tax (“PTET”). This is an important step to allow qualifying pass-through entities to pay Virginia tax on behalf of their owners at the pass-through entity level rather than the owners paying the tax at the individual level, thus avoiding the state and local tax cap on Schedule A of Form 1040.
Understanding Virginia’s New Pass-through Entity Tax
States have enacted legislation to allow pass-through entities to elect to pay state income tax at the entity level. These are commonly referred to as PTET elections. The intention of the PTET elections is to allow individuals to circumvent the $10,000 cap on state and local tax deductions placed on individuals by the Tax Cuts and Jobs Act of 2017 (TCJA). Virginia has established its own version of an elective pass-through entity tax under House Bill 1121, Chapter 690 and Senate Bill 692, Chapter 689 of the 2022 Acts of Assembly. This legislation was enacted for tax years 2021 through 2025.
The Virginia PTET election is made by a “qualifying pass-through entity,” which only includes partnerships and S Corporations that are 100 percent owned by natural persons. In other words, all of the owners of the pass-through entity must be individuals or entities that are disregarded for Federal tax purposes, such as grantor trusts and single member LLCs. The rate of the tax is equivalent to the individual tax rate of 5.75%. Instead of reducing an individual’s income via itemized deductions on their personal return, the deduction will come in the form of state income tax expense at the entity level, which will reduce the net income passed through to the owner on Schedule K-1. Business owners may see great benefit from the additional Federal deductions they would not have otherwise been permitted to take under the TCJA. Cash basis taxpayers may want to consider pre-paying this tax before year end in order to accelerate the benefit of the deduction.
Prepaying the PTET
Virginia allows pass-through entities to prepay the PTET for 2022 via their website using their e-forms. The form for the 2022 Virginia PTET payment is Form 502V. The benefit of making the PTET payment before year end is the ability to accelerate the state tax deduction for Federal tax purposes. Instead of waiting for the benefit of the deduction to come when the tax is paid during tax year 2023, eligible taxpayers can pre-pay the tax by December 31, 2022 and take the deduction, thus realizing Federal tax savings, in 2022. These payments are to be made online similar to estimated taxes. Form 502V can be found via the Virginia Department of Taxation’s online business portal or at the following web address: https://www.tax.virginia.gov/eforms
Draft Guidelines for Virginia PTET
Alternatively, qualifying pass-through entities can wait to file and make a payment with Form 502PTET on or before the due date for the current taxable year. Form 502PTET is due on the 15th day of the 4th month following the close of the entity’s taxable year (for calendar year taxpayers, this would be due April 15, 2023). Estimated payments are not a requirement for the 2022 tax year. Once a PTET return is filed and the election is made by the pass-through entity, all partners/shareholders of that entity are subject to the PTET – no singular partner or shareholder may opt out. It is very important that all partners/shareholders are aware of the PTET and give their consent before the pass-through entity makes the election.
It’s important to note that this guidance is still in draft form and is subject to change. For more information, please see the draft guidelines located here: https://www.tax.virginia.gov/sites/default/files/inline-files/draft-pass-through-entity-guidelines.pdf
If you would like to take advantage of the election and prepay the Virginia PTET, please reach out to your Thompson Greenspon accountant, or contact us at 703-385-8888 or firstname.lastname@example.org.
For more information on the Pass-Through Entity Tax, read our other article here: Understanding Virginia’s New Pass-Through Entity Tax.
Written by Alexander Scott, CPA